Is a Delaware Corporation Right for You?
When you start your new business and you are ready to form a corporation to structure your company, one of your first major decisions will be to select the state of incorporation for your company. For many businesses started in California, the two choices typically are whether you should form a California corporation or a Delaware corporation.
You likely have heard the typical arguments for and against: Delaware has business-focused courts and well developed corporate laws; you should use a California corporation and save some money if your business is located in California; and Venture Capital investors prefer investing in Delaware corporations; etc.
As a Startup company, there are two practical and important reasons why a Delaware corporation may be the better choice for your Startup, allowing you to keep control of the Board of Directors and saving a little money along the way.
Reason #1 – Many Stockholders, Only 1 Director
- If you are starting a new business, you will be very busy handling various Startup matters, including launching new products and services, getting customers, generating revenue, buying equipment, hiring employees, etc. During this initial stage, you may want to maintain control over the initial Startup decisions, including any matters that must be reviewed and approved by the Board of Directors. This control issue may be especially important if you are the main founder or principal stockholder of the company.
- With a Delaware corporation, your corporation can have multiple Stockholders and still have only one Director (you). Even though your Delaware corporation may issue shares to other Founders or Seed Investors, you can still be a Board of one and maintain maximum control over its actions and decisions.
- This type of Board control is not available for a California corporation with more than one Shareholder. Under California corporate law, a California corporation with two Shareholders must have at least two Directors on the Board and a California corporation with three or more Shareholders must have at least three Directors on the Board.
- It can be a challenge at the start of your company to find additional Directors for the Board. Also, if you create a Board of two Directors, then you could face a deadlock situation where the Board vote is split with one Director voting yes and the other Director voting no. And with a Board of three Directors, the two other Directors could end up voting against what you believe to be in the best interests of the company that you created and (want to) control. It also can be an administrative hassle to arrange meetings with multiple Directors or to track down various directors to sign approval documents.
- For many Startup companies, it makes sense that only one person manage and control the Board. You need to get the business up and running to see if there really will be a company that will survive continue. You should not need to be pressured early on to add Directors who may not add value during the Startup phase of your business. Over time, you will have the opportunity to add qualified Directors who will have an important role in shaping the direction of the company. But at the beginning, you do not need the administrative hassles of an expanded Board that you cannot control.
Reason #2 – Election of Directors on Paper
- Most Startup companies have scarce resources and need to be efficient in how they get things done. When managing corporate approvals, it often is more efficient to have the Stockholders and Board take action by written consent (approval where the Stockholders or Directors review and sign a detailed Written Consent document to approve corporate actions), rather than holding an in-person meeting with notice, Quorum, and other formal requirements.
- One annual requirement that the Stockholders have is to elect the Directors who will serve on the Board for the following year. There is a big administrative and cost difference between holding an in-person Stockholder meeting versus covering the required approvals on paper by written consent. Once again, there is a key difference between a California corporation and a Delaware corporation and how directors can be elected by Written Consent.
- Under California corporate law, the Shareholders only can elect Directors by written consent if they get unanimous approval of the Shareholders. In other words, each Shareholder must sign the written consent to elect the Directors for the next year. If a Shareholder is not available or being difficult or unresponsive for whatever reason, then the Written Consent will not work and the California corporation will need to call and hold an in-person meeting.
- A Delaware corporation, however, does not have the same requirement for Stockholders electing the Directors to the Board by written consent. There is no unanimous consent requirement for a Delaware corporation, so long as the required minimum vote is obtained from the Stockholders. If there is less than unanimous consent, then the Delaware corporation must provide notice to the Stockholders who did not provide their consents, but this notice requirement typically is not difficult to meet. The ability to elect Directors on paper with less than unanimous Written Consent can save time and money, two scarce and important resources for most Startup companies.
These practical issues may not be on your initial radar screen when you are planning, starting and structuring your new company. The state of incorporation can help you avoid hassles, costs and headaches as you build and grow your company.
Where do you stand on the California versus Delaware debate for the incorporation of your business? Please share your thoughts, so that other entrepreneurs can benefit from your experience.